The future financial services regulatory regime for cryptoassets in the UK | Global law firm
In general, HM Treasury plans to proceed as proposed. This will include expanding the list of “specified investments” in the RAO to require firms that undertake relevant activities involving cryptoassets by way of business to be FCA authorised. The RAO definition of “financial instruments” will not be expanded to include currently unregulated cryptoassets.
HM Treasury has also confirmed that it considers the DAR a ‘strong, flexible tool’ that is likely to form part of the future financial services regulatory regime for cryptoassets. It has firmly rebutted the suggestion of banning cryptoassets or regulating them as a form of gambling.
Cryptoassets that are not used for one of the listed regulated activities (set out in Table 4A of the HMT Original Proposals) within financial services markets or used as a financial services instrument, product or investment are not intended to be in scope of the proposed regime (although they may be subject to other regulatory regimes). Cryptoassets which are specified investments that are already regulated are also not intended to be captured.
Under the HMT Original Proposals, the mere issuance of a cryptoasset would not in itself be a regulated activity, save where that cryptoasset is a fiat-backed stablecoin. However, the admittance of a cryptoasset to trading on a cryptoasset trading venue would be regulated and public offers of cryptoassets that are not security tokens would also be a designated activity.
The HMT Original Proposals set out proposed requirements in relation to preparation of disclosure / admission documentation, liability requirements, and general marketing requirements. These proposals seek to align with the UK’s proposed Public Offers and Admissions to Trading Regime.
Where there is no issuer of a particular cryptoasset – such as Bitcoin – it will be the responsibility of a cryptoasset trading venue to take on the responsibilities of an issuer if it wishes to admit that asset to trading on its venue.
Trading venues will still be required to define detailed content requirements for admission disclosure documents, but the Government acknowledges industry’s appetite for prescriptive content requirements and supports the idea of a central coordinating body.
In terms of liability, it will use the necessary information test and notes that the proposed recklessness liability standard for certain forward-looking statements, and negligence liability standard for historical, factual statements, will enable market participants to manage their liability provided they make reasonable enquiries.
HM Treasury also confirms its support for the use of publicly available information to compile appropriate parts of the disclosure and admission documents, as long as those preparing the documents are clear on where the information originated from and the level of due diligence they have done on it.
FCA rules will specify the requirements for backing assets for fiat-backed stablecoins issued under this activity, as well as holding them under a statutory trust and the requirements for redemption rights and capital requirements (amongst other things). If the stablecoins were to be recognised by HM Treasury, BoE’s proposed rules (which have some important differences) would apply.
HM Treasury noted that the regulators would consult on these rules before they come into force, and they began this process on 6 November 2023 with the publication of their discussion papers. In DP23/4, the FCA sets out its proposed approach to regulation around issuing and holding stablecoins, which (under the HMT Final Proposals) will include authorisation requirements for firms wishing to issue fiat-backed stablecoins in or from the UK, or to carry out custody activities in relation to stablecoins from the UK or to UK based consumers.
The FCA’s and BoE’s November discussion papers cover their proposals to implement the regulation of stablecoins for use in payments in the UK. Under the HMT Final Proposals, the FCA will regulate the use of stablecoins as a means of payment under the PSRs using two possible models (the ‘hybrid model’ and the ‘pure stablecoin model’), while the BoE will regulate operators of systemic payment systems using stablecoins, service providers that provide essential services to those systems and service providers that are systemic in their own right.
The HMT Original Proposals clearly anticipated that operators of cryptoasset trading venues would need to establish a UK-based entity if they wished to be authorised under the regime.
HM Treasury suggests that UK firms that operate a regulated crypto trading venue in an overseas jurisdiction could be permitted to apply for authorisation for a UK branch extension of their overseas entity. However, the FCA would determine the specifics of requirements on location in line with existing practice in the UK.
HM Treasury proposed segmented requirements for firms performing cryptoasset-related regulated activities, so rather than one chapter of provisions relating to cryptoasset service providers in general, separate provisions would apply to trading venues, intermediaries, lending platforms and custodians.
Cryptoasset intermediaries would need to comply with a range of ongoing requirements once authorised, including best execution, conflicts, appropriateness, data reporting, capital requirements, outsourcing and operational resilience standards, and governance requirements.
HM Treasury has confirmed that it plans, in general, to take forward its proposed approach. It will define a set of new regulated activities relating to the intermediation of cryptoassets, drawing from analogous activities in the existing regulatory perimeter.
The legislative approach and subsequent rules set by the FCA will be designed with careful consideration of specific aspects of crypto markets and implications for concepts which may not map across well from the traditional financial services sector.
Operators of cryptoasset trading platforms would be prohibited from dealing on own account on their platform. They would, however, be able to engage in matched principal trading, subject to client consent. Transparency requirements, akin to those applicable to securities trading venues would also be applicable.
Having understood that there are numerous business models and execution protocols, HM Treasury reports that the Government does not intend to explicitly endorse or prohibit specific ones.
Firms intending to operate a cryptoasset trading venue will be required to obtain FCA authorisation for that activity, and will provide a crucial function in terms of admitting cryptoassets to their venue and conducting due diligence over them.
As there are various types of cryptoasset borrowing and lending arrangements, involving different business models, market participants and risks, HM Treasury notes that it would not make sense to regulate all borrowing and lending activities in the same way or adopt a single model of traditional lending regulation for all crypto lending arrangements. There will therefore, for example, be a clear differentiation between lending to retail consumers and lending between wholesale counterparties, with centralised lending platforms to retail consumers being prioritised for regulation and likely to be subject to additional requirements.
In DP23/4, the FCA sets out its proposed approach to setting the standards that should apply to custody of regulated cryptoassets (or the means of accessing them, such as private keys). While this covers custody of regulated stablecoins and security tokens, the FCA notes that, subject to feedback, it is likely to apply a similar approach to custody of other cryptoassets that come into regulation in the future.
However, HMT stated its intention to seek to establish equivalence arrangements for overseas firms subject to comparable obligations.
FCA DP23/4 also discusses the potential for overseas stablecoins to be used for payment in the UK (as proposed by HM Treasury), provided they meet equivalent standards. HM Treasury is exploring the possibility of creating a new activity of acting as a ‘payment arranger’ to assess and approve overseas stablecoins for this purpose.
The Government agrees that additional guidance should be made available by the regulator to provide clarity on what constitutes market abusive behaviour (including a non-exhaustive list of examples). The Government also agrees that key aspects of the regime will need to be periodically reviewed and assessed given the dynamic nature of the industry.
In DP23/4, the FCA notes that for the proposed regime for regulated stablecoins, it is exploring how the existing financial crime framework in FSMA and the MLRs can be applied, as well as any potential amendments to the Handbook that may be needed, in line with the approach of same risk, same regulatory outcome. The FCA says it considers it proportionate for regulated stablecoins issuers and custodians to be subject to the same financial crime rules and operate in the same way all FSMA authorised firms are expected to act.
There is a suggestion that secondary legislation to effect phase 2 (covering a wider range of cryptoassets and activities) of the regime will be laid in 2024, subject to Parliamentary time – a key caveat given the forthcoming General Election. The FCA will then need to design various aspects and consult on changes to its rules to operationalise the new regime.
HM Treasury acknowledges the need for sufficient transitional disclosure arrangements for well-established tokens such as Bitcoin, in order to reduce the risks and impacts of “cliff edges” and avoidable removals from trading in relation to the back book of tokens already in circulation. However, no other transitional arrangements are being proposed at this stage.
